Morgan Stanley (NYSE:MS) has recently lifted its recommendation on shares
in Associated British Foods (LON:ABF) to an ‘Overweight’ due to the low
valuation it says is being applied to the Primark business in comparison to
Inditex.

In the same note to investors, analysts at Morgan Stanley pointed out
that Primark’s implied valuation “seems anomalous” compared with that of
Inditex on 20 times earnings — especially as Zara, the Spanish fashion
group’s flagship brand, carries higher maturity. On the upside, the private
bank’s analysis team advanced that profits at Primark “are likely to
inflect positively” over the next 12 months.

"We see AB Foods and Inditex as the ‘quality’ names in our coverage
universe. Both have sold off significantly in recent months, but we believe
that it is AB Foods, rather than Inditex, where this has created a buying
opportunity... we think profits at Primark are likely to inflect positively
[over the next 12 months], whereas we see no sign of the foreign exchange
headwinds that are hampering Inditex abating."

Primark has just revealed that its operating profit margin in the
half-year fell from 11.6 to 10.4 percent despite sales growth of 7 percent.
Adjusted operating profit was slightly up (+ 4 percent to 341 million
pounds) in the six-month period.

Is ABF too reliant on its Primark business?

An uplift in the ABF share price in recent weeks suggested the market
had been hoping for a similar performance today, explain market sources
quoted by the ‘FT’.

However, and despite an unseasonably warm winter that impacted the
retailer’s warm clothes sales, record sales in the week before Christmas
and a peak in operating margins in February have lifted ABF’s hopes, which
now expects an acceleration in Primark’s profit growth in the second half
as a result of an improvement in margin over the same period last year.

Associated British Foods is starting to rely “too much” on its fashion
arm, with Hargreaves Lansdown analysts noting that “Primark is the most
important division within ABF . . . it already contributes over half of
profits”, the slower half year hit group results.